US politicians have been less successful in reaching a debt ceiling resolution, with a compromise deal still out of hand. Market confidence remains delicate and volatility could pick up again. We remain most preferred on bonds relative to equities, and expect more dollar weakness ahead.
Market confidence took a hit in March on sudden financial sector stress.
- Acute banking sector stress—punctuated by the failure of Silicon Valley Bank on 10 March—had sparked broader concerns over solvency, liquidity, and profitability.
- At the time, US Treasury yields fell sharply and bond futures shifted to price fairly sharp Fed rate cuts on worst-case expectations a recession could be imminent.
- The urgency of banking sector strains in effect pushed the debt ceiling debate to the background.
But while credit fears have eased, the debt ceiling impasse has worsened.
- US and European policymakers acted swiftly to stem banking sector risks, with coordinated liquidity measures and rapid rescue deals.
- Debt ceiling talks remain tense, with negotiators at times walking away or accusing each other of “not being serious.”
- Differences between debt-hardliners and progressives offer little voting margin for a compromise deal.
So investors still should consider diverging outlooks for equities, bonds, and other asset classes.
- We think a last-minute debt ceiling deal is the most likely outcome.
- With all-in yields still high, we rate bonds as most preferred and suggest investors lock in attractive yields now, with a tilt to quality bonds.
- We rate both the US dollar and equities as least preferred, with the latter likely to deliver limited returns and high volatility over the rest of the year.
Did you know?
- In response to banking sector pressure, the Fed announced a new Bank Term Funding Program (BTFP), offering banks the possibility of taking loans of up to one year against US Treasuries and other collateral.
- Investors tempted to sit on the sidelines during periods of market volatility should know that this often results in being under-invested when a new sustainable bull market begins.
- Prior examples suggest a last-minute debt ceiling deal is the most likely outcome. The government has set an official 2023 GDP target of "around 5%," prioritizing boosting domestic consumption.
We prefer bonds over equities, and think investors should lock in high yields now, with a tilt to IG and HG bonds. We also recommend selective equity exposure in EMs (like China) or via sectors like consumer staples, industrials, and utilities. We expect USD weakness to continue, and suggest investors consider real assets like commodities and infrastructure, or alternatives like hedge funds and private markets.
Main contributors - Jon Gordon, Vincent Heaney
Content is a product of the Chief Investment Office (CIO).
Original report - How do I position amid debt ceiling, credit risks?, 22 May 2023.